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EUA supply curbed as Market Stability Reserve bites

Teeth set to be sharpened by further strengthening of the mechanism

  • The European Commission has published its TNAC and MSR calculations
  • MSR set to withhold an incremental 348m EUAs from fresh supply; c50% of auction volumes
  • Further strengthening of the MSR is working its way through the European Parliament

On 12th of May the European Commission published its annual calculation of the Total Number of Allowances in Circulation (TNAC); the figure that determines how many EUAs will be withheld from the market and placed into the Market Stability Reserve (MSR).

The TNAC represents a simple mathematical subtraction: all the compliance instruments (EUAs that have been issued or auctioned by member states and the Commission as well as offsets used for compliance), minus all the cumulative verified emissions, as well as voluntarily cancelled EUAs.

The calculation of the TNAC covers the period dating back to the start of Phase 2 of the EU ETS, which began in 2008. During the period between 2008 and 2020, installations were able to use carbon offsets generated under the Kyoto Protocol, in addition to EUAs, to comply with the cap on emissions.

The TNAC was calculated at 1.654 billion tonnes in 2018, falling to 1.385 billion tonnes in 2019, and increasing again to 1.578 billion tonnes in 2020 on the back of lower emissions due to Covid-19. The 2021 calculation, published on the 12th of May, sets the surplus of allowances in the market at a total of 1.449 billion EUAs at the end of 2021.

The 2021 TNAC represents a decrease in the surplus of 129 million tonnes (-8%) from the previous year, reflecting a revival in the use of coal to generate power in Europe, as natural gas prices rose to record highs.

At the same time, industrial output and emissions also recovered as the bloc emerged from the shadow of the pandemic.

The Market Stability Reserve’s goal is to maintain the total available supply of EUAs within a target range of between 400 million and 833 million EUAs each year, a sum which is calculated to be sufficient to allow power generators to hedge their forward power sales each year.

Each year in which the supply of EUAs is above the target range, the MSR is calibrated to withdraw 24% of the TNAC, in order to drive  supply down, to within that 400-833 million “corridor”. It does this by subtracting that calculated amount from the auction supply over a 12 month period from September to August the following year, and placing those un-auctioned EUAs in the Reserve. From 2023, most of the EUAs held in the reserve will be cancelled.

The MSR received 397 million EUAs in 2018-19, 332 million EUAs in 2019-20 and 379 million EUAs in 2020-21. In 2021-22, it will take in 348 million EUAs.

SparkChange’s EUA ETC supports the TNAC reduction

SparkChange Physical Carbon EUA ETC performs a similar function to the MSR. By investing in physical EUAs and withholding them from the market, investors restrict the supply of EUAs in much the same way as the MSR does.

As long as the MSR operates, buying and holding EUAs creates a lasting emission reduction even if the EUAs are divested at a later stage.

SparkChange therefore amplifies and accelerates the work of the MSR, and drives incremental reduction in emissions across the EU.

While the MSR goes about its task over the coming year, however, there are moves afoot in Brussels to strengthen its parameters even further.

Strengthening of the MSR

Changes to the reserve are being discussed as part of two legislative “files” in the European Parliament. Firstly, a specific proposal to amend the MSR has been agreed by two leading committees in the Parliament.

The MSR is presently set to operate at a 24% intake rate until 2023-24, after which it will reduce its annual intake rate to 12%. However, the industry and environment committees in the European Parliament have already agreed to extend the 24% intake rate until the end of the current phase of the market, which comes in 2030.

This amendment will go before the full Parliament for ratification later this summer, though there are overlapping amendments being discussed

It’s likely that the extension of the 24% intake rate will also be agreed with the Commission and the Council, the co-legislators.

A second set of discussions, however, involves a more thorough reform to the EU ETS as a whole, and this track of talks has also floated some proposals to change the parameters dictating when the MSR should operate.

Instead of drawing down supply until it reaches the maximum 833 million EUAs, some lawmakers have suggested cutting supply further, to an upper threshold limit of 700 million allowances.

The change to the intake rate will ensure that annual withdrawals of excess supply from the market are larger and therefore more meaningful in drawing down the historical surplus of allowances.

The impact of these changes will be to restrict the supply of EUAs to the market even further, triggering incremental abatement and driving more investment into low-carbon alternatives. On a practical level, tighter supply will also mean higher EUA prices for longer.

Spark Change Group Limited (FRN 944451) is an Appointed Representative of Kroll Securities Ltd. (FRN 466588) which is authorised and regulated by the Financial Conduct Authority.

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